Australian Fund Stocks up on CTI Shares

Forager has recently become a substantial shareholder in CTI Logistics (CLX), a courier and warehousing services company. CTI has a strong competitive position within the Perth delivery market where it carries out 30% of on-demand taxi-truck deliveries, 35% of courier deliveries, and 40% of same-day parcel deliveries. CTI also provides third party contract warehousing and it’s the national market leader in storage and distribution of floor coverings such as vinyl and carpet.

Cooling WA Economy Creates Opportunity

The end of the mining boom is hurting the company’s businesses. In 2016, CTI generated $150m in revenue but only $2m in net profits. As you can see in the chart below, the company’s share price has plummeted from as high as $2.75 in 2013 to $0.84 cents today – a 69% drop. CTI’s current market capitalisation is only $62m.

While last year’s sales reached the highest level on record due to an acquisition, profitability was well below what CTI has earned in the past. In 2014 and 2015 net profits were $10m and $6m respectively on a much lower revenue base.

Since then, competition has increased and demand for the company’s services fallen, but CTI should be able to adjust its cost structure to the new market conditions. CTI only owns a small fraction of the vehicles it uses and most of its workers are contractors.

Once the economy recovers CTI should bounce back. Its 30-year old delivery network is a hard asset to replicate. Furthermore, the flooring business should continue to grow as it benefits from a new bigger warehouse.

Based on the 2017 half-year result, CTI should be able to earn net profits of about $6m for the full year. This implies it’s trading at a multiple of about 10 times these ‘depressed’ earnings. Importantly, the company has net tangible assets of $63m and $20m worth of franking credits. These provide today’s investor downside protection.

Strong Management Team

While we don’t spend much time talking to management we strive to understand whether their interests are aligned to those of shareholders. We also look at their past capital allocation decisions to gauge how capable they are in their line of business.

Insider ownership is usually one of the first things we look at when assessing management – there is no bigger incentive than ‘having skin in the game’. Management turnover is also an important factor. CTI’s three main directors own nearly 60% of the company and have at least 30 years of history with the business – each.

While a long tenure and significant insider ownership are big positives, they can mean little without good financial performance. On this score, CTI’s directors have done an outstanding job over the years. Book value per share has grown from 18 cents in 2004 to $1.25 today, a compound annual growth rate of 17%. This is even more impressive when considering the company paid 58 cents in dividends per share over the period.

Given the attractive valuation and management’s great track record, Forager bought shares in the company in late May. This has mostly happened through a small placement of new shares. About 2.4% of the Forager Australian Shares Fund is invested in CTI Logistics.

LIT Structure Serving its Purpose

While it is a promising investment, CTI’s shares are extremely illiquid with only a few thousand shares trading a day. Investing in illiquid securities is not a problem per se. In fact, it’s often one of the reasons why a stock might be mispriced. But, it presents some challenges for fund managers, especially those who manage open-ended funds.

The Australian Fund has historically held many stocks that have low trading liquidity. This required the Fund to keep a high cash balance at all times in order to protect the Fund from an unusually large number of investors deciding to redeem their units at once. Trying to sell illiquid stocks on the market in a hurry can obviously be costly.

Since the Fund closed to new investors and converted to a Listed Investment Trust (LIT), Fund liquidity is not a concern. CTI is exactly the sort of business we had in mind when making the change.

This is an extract from the upcoming June 2017 Quarterly Report. Please click here if you wish to sign up to receive the Quarterly Report.

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4 thoughts on “Australian Fund Stocks up on CTI Shares”

Thank you for bringing to light an interesting opportunity. Given a lot of distressed assets in the sector, the share placement might make sense from a capital allocation perspective – is that the case?

Thanks Forager team for sharing with us opportunities that the fund finds interesting. The fund, given its investing philosophy and size will invariably invest in out-of-favour small cap names that exhibits value and significant margin of safety. Taking the CTI Logistics example, how does the fund view the catalyst required to realize the value here? I am curious to know how the fund thinks when it comes to value realization of its stock investments.

The main catalyst is the low price itself. If we can buy a business for a lot less than what we think it’s worth then we should make money over the long term as other investors spot the opportunity. Obviously this isn’t easy and we make mistakes too.

In this particular case we think CTI has a great management team which should continue to grow the business and allocate capital wisely. CTI should also continue to pay dividends. So we don’t need explosive share price performance to obtain an acceptable return from our investment.

Forager Funds Management provides general information to help you understand our investment approach. Any financial advice we provide has not considered your personal circumstances and may not be suitable for you. Please read our Comment Policy.

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Forager Funds Management provides general information to help you understand our investment approach. Any financial advice we provide has not considered your personal circumstances and may not be suitable for you.

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